Justice Martin
Associate Editor
Loyola University Chicago School of Law, J.D. 2024
In the past, insider trading cases have been considered difficult to prove and prosecute. These cases usually require extensive evidence-gathering coupled with a high burden of proof. However, the Securities and Exchange Commission (SEC) and Justice Department are now turning to new developments in technology and regulatory efforts that have led to an increased focus on investigating and prosecuting insider trading cases. Why were these cases hard to prove in the past and what exactly are these new technologies?
Why are these cases hard to prosecute?
Insider trading has long been an issue in the United States. According to the SEC, insider trading generally involves the “buying or selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.” Violations of insider trading laws can also include “tipping” of such information, securities traded by the person with “tipped” information and securities trading by individuals who misappropriate such insider information. Insider trader’s actions run afoul of several securities laws, including the Securities Exchange Act of 1934 and the Securities Act of 1933. Along with these baseline insider trading statutes, the Insider Trading and Securities Fraud Enforcement Act of 1988 strengthened the penalties and enforcement for insider trading and securities fraud. The penalties for insider trading include fines, imprisonment, and civil lawsuits. Insider trading is also prohibited by several stock exchange rules and regulations, including the New York Stock Exchange and Nasdaq Stock Market.
Historically, insider trading cases have been difficult to prosecute due to prearranged trading plans, also known as 10b5-1 plans. 10b5-1 plans stem from an SEC regulation passed in 200 and they can potentially insulate violators of insider trading laws by creating a defense that the traders did not engage in actions consistent with insider trading. These written plans are usually created by executives of a company with the advice and consent of their in-house lawyer(s). Plans specify a pre-determined trading schedule, usually outlining when and how many shares of company stock will be bought or sold. Trading according to this pre-arranged plan creates the argument that the trade was made in accordance with the plan and not based on any material, non-public information.
Pre-arranged trading plans can provide a legal defense against insider trading allegations, but they do not provide complete immunity from prosecution or regulatory enforcement. Regulators looking to challenge the trading as running afoul of insider trading laws will need to show that “an executive has market-moving, undisclosed information and intended to trade on it at the time he or she set up the plan.”
What are these new techniques?
Academic Research conducted at the Stanford Graduate School of Business discussed potential legal “red flags” that are seen with abuse of a 10b5-1 plan. For example, if an insider modifies or cancels a 10b5-1 plan shortly before or after material non-public information is released, this could suggest an effort to manipulate the stock price by using the plan to take advantage of insider information. Further, these plans are usually signed off by the in-house lawyer and sometimes covered by the attorney-client privilege, causing regulators to be placed in difficult situations. The authors offer potential solutions for the SEC, such as utilizing their rulemaking authority, to amend the 10b5-1 rules by requiring insiders to disclose all 10b5-1 plans and their targets, as well as establishing limits on the size and frequency of trades made under these plans.
Currently, the Justice Department, working closely with the SEC, has criminally charged Ontrak Inc. CEO Terren Peizer with illegal trading while using his 105b-1 plans in 2021. They were able to employ new techniques in order to reach charges for the CEO of the telehealth provider. Prosecutors at the DOJ’s criminal division employed data analysis while scrutinizing Mr. Peizer’s trades, and this is the first time an insider trading defendant who uses a 10b5-1 plan has been criminally charged. The SEC found Peizer’s trades by using their data-driven program that investigates executive trading according to 10b5-1 plans. His trading plans allowed him to avoid over $12 million in losses, as he sold millions of dollars of stock after learning of his company losing lucrative contracts with other companies.
The Justice Department has also employed other techniques in order to flag violators of insider trading laws including data mining, inspecting physical evidence like incriminating chat messages, and the testimony of cooperating witnesses. Despite these new efforts, insider trading cases can still be challenging to prove and prosecute. However, heightened focus on these cases and the use of advanced technology may lead to more successful investigations and subsequent convictions in the future.